'Junk' sovereign rating puts ceiling on Brazil bull market

SAO PAULO Oct 10 Brazilian financial markets
are unlikely to repeat their dramatic rally in 2016 even if
Congress approves a business-friendly reform agenda during the
coming year, as asset values are nearly at the ceiling of the
country's junk credit rating.

Brazil's bonds, stocks and currency have been among the
best-performing assets in the world this year as investors
welcomed promises by new President Michel Temer to pass measures
capping spending and trimming public pensions.

Investors are now waiting anxiously to see if Temer can make
good on those promises, but even if a fragmented Congress
approves his ambitious reform agenda, analysts say there is
little room for more dramatic rises.

"Brazil has gone a long way and much of the good news is
already priced in," said Viktor Szabo, a portfolio manager at
Aberdeen Investments, who is reducing exposure to the Brazilian
government's dollar-denominated debt.

Promises of reforms have already made investors far more
willing to lend to Brazil. Yields on 10-year Brazilian
local-currency bonds narrowed by more than 500 basis
points so far this year, setting off an accompanying "cost of
capital" rally for stocks, according to Credit Suisse analysts.

Brazil's five-year credit default swaps (CDS)
, a gauge of default risk, paved the way for this
year's bull market by rallying to 264 basis points on Monday
from nearly 500 at the start of the year.

That is below the average of 294 basis points for countries
that share Brazil's double-B credit rating from the three main
ratings agencies, testing how far spreads can go for Latin
America's largest economy without an investment-grade rating.

The CDS of triple-B-rated countries trade as high as 240
basis points, as in the case of South Africa, and average around
140 basis points.

All three major agencies stripped the country of its
investment-grade rating between September 2015 and February
2016.

Brazil is currently rated "BB", "BB" and "Ba2" by Standard &
Poor's, Fitch Ratings and Moody's Investors Services,
respectively, all with negative outlooks.

Gabriel Gersztein, a strategist with BNP Paribas, said
Brazilian CDS could fall to about 200 basis points by the end of
2017 if Temer's fiscal efforts are successful.

That would put them in line with Russia, which is rated
"BB+", "BBB-" and "Ba1" by S&P, Fitch and Moody's, respectively.

"There could still be some improvement, but at a slower
pace," Gersztein said.

A Reuters poll of analysts forecast a 5.5 percent rise for
Brazil's benchmark Bovespa stock index to 65,000 points
by the end of 2017 after a 42 percent rally so far this year.

A separate poll showed the Brazilian real weakening
to 3.43 per dollar in the next 12 months, from 3.21 currently.

Brazil reached investment-grade status for the first time in
2008, as a commodities boom and policies mixing fiscal restraint
with social programs made the country an investor darling.

However, crashing commodity prices, a deep recession and big
budget deficits have trashed that reputation in recent years.

A Fitch study showed countries that lost their
investment-grade ratings took 6.1 years on average to recover
them.

"At this juncture, we do not foresee Brazil returning to
investment grade in the next two years," Fitch's Shelly Shetty,
head of sovereign analysis in the Americas, told Reuters.

"Even if the government's proposed fiscal measures are
passed, the debt burden will not decline in the near-term."

Her comments echo remarks by Moody's senior analyst Mauro
Leos, who told Reuters last month that Brazil will not return to
investment grade before the end of Temer's government in 2018.

In an interview with Reuters last week, a senior analyst
with S&P also said that Brazil is still years away from
returning to investment grade.
(Reporting by Bruno Federowski; Editing by Brad Haynes and
Diane Craft)

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